Investing for jobs: Capital Spending Review 2021-2022 to 2025-2026

Chapter 2: Delivering Fiscal Sustainability and 5-year Funding Aggregates

Outlook for future Capital and Financial Transactions Grant

The Medium-Term Financial Strategy 2021 sets out likely future grant levels for Scotland, based on a range of assumptions.  It noted that the UK Government’s latest Spending Review provided budgets for 2021-22 only, and did not provide the information needed for long-term planning. This settlement forms the basis of a central scenario, which beyond 2021-22, assumes that the Scottish Government Block Grant grows in line with spending plans set out by the Office of Budget Responsibility.  The forecast future capital grant, financial transactions and borrowing is as set out in the table below.

Table 01: summary central scenario outlook for UK funding

£ million (nominal)	2021-22	2022-23	2023-24	2024-25	2025-26
Capital Budget Limit	4,973	5,260	5,558	5,757	5,986
Financial Transactions	208	208	0	0	0

These figures have been used as a basis for our future planning for portfolio allocations throughout the Capital Spending Review period.  The plans set out by the Office of Budget Responsibility are more optimistic in later years than the forecasts given by HM Treasury itself.  As such, later years’ capital borrowing has not yet been built into National Infrastructure Mission planning, to permit flexibility to respond to the risk of a different UK settlement to the above, whilst still offering certainty to portfolios and confidence in their own future allocations.

Types of Funding and Financing of the National Infrastructure Mission

Scottish Ministers are committed to ensuring that the Scottish Government’s financial planning is sound and sustainable.  In this section we highlight the key factors underpinning the fiscal sustainability of our capital investment plans.

Just under 85% of the Scottish Government capital budget, including new Financial Transactions funding, flows from UK Government decisions and allocations.  The remaining sums arise from income and receipts, deployment of Scottish capital borrowing powers, from innovative financial and revenue finance models, and from recycling repayments from earlier FT loans.

Capital Borrowing

In addition to the capital block grant, the Scottish Government can increase capital expenditure through borrowing up to £450 million per year up to a maximum total of £3 billion. While these powers enable the Scottish Government to support the capital investment programme and promote economic growth in Scotland, there are limitations to their use.  The Scottish Government capital borrowing policy is set out in the Medium-Term Financial Strategy^[4].

Financial Transactions

Financial transactions (FTs) are a type of capital funding, initially introduced by Treasury in 2012-13. They are available for equity investments, or loans to individuals or private or third sector organisations, such as companies or universities. FTs must be repaid by the Scottish Government to the UK Government.

Previous FT budgets have been used to good effect in Scotland, such as to grow early stage innovative companies or to improve people's chances to own their own home.

FT consequentials to Scotland have predominantly arisen from UK Government funding of the English 'Help to Buy' housing scheme, which had been expected to conclude in March 2023. Intentions thereafter are not yet known, and will likely only become clear in a full UK Comprehensive Spending Review.

The FTs confirmed in the one-year UK 2020 Spending Review were cut very significantly, as below.  No indication was given on the future of FTs after 2021-22.   The reduction was principally due to a significant and early scaling back of the English “Help to Buy” scheme.

Table 02: Financial Transaction Allocation, £m

£m	HMT actual FT funding in Budget 2020-21	HMT 2021-22 FT allocation	% actuals change
FTs total	620.0	208.0	(66.5)

Within the total FT funding available to the Scottish Government, it has not been possible for us to fully mitigate this reduction, coupled with a £218 million negative Capital consequential flowing from reductions the UK Government has made to comparable Housing budgets in England.  The Scottish Government has expressed the view that the UK Government’s approach appears to contradict the commitment in the UK Spending Review to multi-year funding for housing, specifically:

“nearly £20 billion of investment underpinning the [UK] government’s long-term housing strategy, including £7.1 billion for a National Home Building Fund and confirming over £12 billion for the Affordable Homes Programme”

We have sought clarification about the UK Government’s plans for future housing funding.  In the event that additional clarity or funding is provided in the March UK Budget, the Scottish Government will review the options this presents for the overall capital programme, including affordable housing supply.

As a result of the significant and unexpected reduction in the FT budget allocation, the Scottish Government has had to take tough decisions on the projects and programmes that will be funded by this method going forwards.

Priority has been afforded to ongoing delivery of existing low carbon investments and to the capitalisation of the Scottish National Investment Bank (SNIB), to support a strong, sustainable low carbon economy.

Additionally, and in recognition of the key role that Financial Transactions funding has played in our Affordable Housing Supply programme and shared equity schemes over many years, the Scottish Government has targeted the additional £100 million Reserve drawdown flexibility in 2021-22, available due to the Scottish Fiscal Commission’s assessment that there has been a Scotland-specific economic shock, on boosting our affordable housing investment next year and continuing shared equity scheme support for first time buyers into 2021-22.

Revenue-Financed Investment

The Scottish Government uses revenue finance to deliver additional high-value infrastructure projects, which could not be delivered with capital grant alone. Such infrastructure projects are financed through annual payments or increased tax revenue, typically over a 25- to 30-year period.

The affordability and sustainability of all Scottish Government long-term revenue commitments, including repayment of debt stock, are assessed as part of the Budget process. Annual costs of revenue finance commitments are managed within a maximum of five per cent of the Resource budget available (excluding social security).

In 2019, the Scottish Futures Trust compiled a report^[5] considering the options for future deployment of private finance in Scotland. Of the available choices, it recommended adoption of the Mutual Investment Model (MIM), a variant of a Welsh approach.

In the 2019 Medium Term Financial Strategy, we accepted this recommendation and confirmed that, although this financing approach can provide valuable additionality, in recognition of the overall costs, MIM would be reserved for schemes delivered by the Scottish Government itself, its agencies or related bodies.

As identified by the Scottish Futures Trust, MIM is most suitable for a pipeline of similar projects or schemes, each of which has a capital asset value of more than £20 million, rather than a more diverse suite of smaller projects. The market is aware that the deployment of MIM for remaining stages of the A9 is being explored and developed.

An outcomes-based model of revenue finance has also been developed for working with Councils to deliver the Learning Estate Investment Programme. Similarly, outcomes finance aims to be utilised for Green Growth Accelerators.

Our pilot Tax Incremental Finance (TIF) investments, established in previous years, also continue to form part of the overall investment landscape.  These permit Councils to retain the increase in Non-Domestic Rates income arising from increased business activity within zones where their targeted capital investment has taken place.  Existing Growth Accelerator investments, in Edinburgh and Dundee, are also continuing, with Scottish Government resource payments made to those Councils if economic and other performance indicators are met as a result of their own increased infrastructure investment in specific schemes.

The Scotland Reserve

The Scotland Reserve allows the Scottish Government to smooth spending within and between years. The Reserve is capped in aggregate at £700 million, by the provisions set out in the Fiscal Framework.  This is only around 1.4% of the nearly £50 billion total Scottish Budget in 2020-21.

Annual drawdowns from the Reserve are normally limited to £100 million for capital (including financial transactions). This severely restricts the Scottish Government’s ability to build up a medium-term reserve and draw down funding in line with investment cycles.

As noted earlier, the Scotland-specific economic shock that the Scottish Fiscal Commission has forecast for 2021-22 has resulted in the temporary ability to drawdown more than this limit of capital in 2021-22 and each of the two subsequent financial years.  The overall £700 million cap does however still remain in operation and acts as the ceiling for reserved Resource and Capital funding combined.

Stakeholder Expectations of the National Infrastructure Mission

Scottish Ministers welcome the contributions other stakeholders have offered around a likely detailed trajectory or plan to deliver the National Infrastructure Mission, most notably estimates published by Audit Scotland in 2020 in their report Privately Financed Infrastructure Investment – The Non-Profit Distributing Model (NPD) and Hub Models^[6].

This report offered a credible external estimate of trends in Capital budgets and is reproduced here with the permission of Audit Scotland.

Exhibit 9 The current trend in capital budgets, 2019-20 to 2025-26

The Scottish Government may need to use a variety of funding sources, potentially including private finance, to meet its target to increase investment in line with the National Infrastructure Mission.

Note: Our analysis uses the National Infrastructure Mission Baseline from the Scottish Government’s 2019 Medium Term Financial Strategy (MTFS), based upon its modelled central scenarios until 2023-24 (and thereafter kept level). This provides projections of the capital grant and Financial Transactions funding, as well as expenditure on innovative financing schemes, over the seven-year period 2019-20 to 2025-26. In line with the MTFS, our analysis assumes no NPD/hub investment after 2020-21 and does not forecast the levels of capital borrowing after this point (current powers allow the Scottish Government to borrow up to £450 million each year). The Scottish Government committed in the MTFS to 'steadily increasing' infrastructure investment by £1.56 billion between 2019-20 and 2025-26 but goes into no further detail as to how this will be profiled or achieved. We have used the Scottish Government’s baseline figures and then assumed that this increased investment will take place in equal annual increments of £0.26 billion of additional investment (year on year) between 2019-20 and 2025-26. This allows annual investment levels, and the additional funding that may be required to meet the National Infrastructure Mission’s commitment, to be estimated. With no changes in the baseline projections, this will need to funded through capital borrowing, MIM or by other means.

Source: Audit Scotland

Capital Spending Review investment and the National Infrastructure Mission

The table below sets out the high-level funding and finance plans in this Capital Spending Review, showing that they are more than sufficient for Scottish Ministers to deliver against the ambitious National Infrastructure Mission investment target.

Table 03: High-level funding and finance plans

Year. All figures (£m) rounded	2021-22	2022-23	2023-24	2024-25	2025-26	Total (5 years)
UK capital allocation	4,973	5,260	5,558	5,757	5,986	27,534
Capital receipts or income (estimated)	62	73	85	76	49	345
Capital borrowing	450	450	250	-	-	1,150
FT consequentials	208	208	-	-	-	416
FTs recycled	144	140	140	140	140	704
Reserve drawdown (FTs in first two years, then CDEL)	200	100	0	12	0	312
Revenue Finance	50	200	750	1000	1000	3000
Total Investment	6,087	6,431	6,783	6,985	7,175	33,461
Audit Scotland modelled NIM trajectory (rounded)	5,700	6,000	6,200	6,500	6,800	31,200
CSR additional investment above NIM trajectory above	387	431	583	485	375	2,261

Budget level 1 allocations across the Capital Spending Review Term

The table below gives total, Budget level 1 capital grant net allocations by portfolio over the five financial years of the Capital Spending Review.

Table 04: Capital grant level 1 net allocations

Year (£m)	2021-22	2022-23	2023-24	2024-25	2025-26	5-year total
Communities and Local Government	1,363.0	1,375.0	1,395.0	1,448.5	1,483.5	7,065.0
Environment, Climate Change and Land Reform	303.0	296.0	291.0	288.5	289.0	1467.5
Education and Skills	398.0	434.0	443.4	411.6	418.8	2105.8
Economy, Fair Work and Culture	130.6	152.4	121.0	132.8	131.7	668.5
Health	529.0	521.0	428.0	428.0	428.0	2,334.0
Justice	166.5	166.0	226.0	283.0	171.0	1,012.5
Rural Economy and Tourism	163.2	150.8	150.1	159.5	163.1	786.7
Social Security and Older People	93.0	75.7	62.4	32.0	60.0	323.1
Transport, Infrastructure and Connectivity	2246.8	2374.1	2552.6	2527.9	2652.8	12,354.2
Finance	27.7	158.6	132.1	49.8	180.7	545.2
COPFS	4.8	5.3	5.3	6.3	6.3	28.0
Parliament	1.1	1.1	1.1	1.1	1.1	5.5
Total	5,423	5,710	5,808	5,769	5,986	28,696

The Capital Spending Review provides an outline five-year allocation for Local Government general capital grant and other specific funding streams, and reflects the 2021-22 Capital allocations proposed in the Scottish Budget 2021-22 and the financial planning assumptions in the Capital Spending Review Framework^[7] published in September 2020.  Future Capital budgets for Local Government will be agreed in consultation with COSLA as part of the annual budget process and wider engagement about the delivery of shared outcomes and priorities.

The Annex shows level 2 and level 3 budget allocations, by portfolio, across the same period.  Figures for 2021-22 reflect those published in the Scottish Budget 2021-22.

Fiscal Sustainability

Scottish Ministers are committed to ensuring that the Scottish Government’s financial planning is sound and sustainable.  In this section we highlight the key factors underpinning the fiscal sustainability of our capital investment plans.

As set out in the Medium Term Financial Strategy 2021, the following principles guide decisions by Scottish Ministers on the sustainable use of our fiscal powers:

• Stability – ensuring steady funding and expenditure trajectories
• Budget flexibility – including the ability to respond to unforeseen events.
• Intergenerational fairness – ensuring future taxpayers only bear the cost of spending that benefits them.
• Value for money – Borrowing and other sources of revenue-finance investment will achieve value for money for the taxpayer.
• Transparency – The Scottish Government will set out clearly its planned and actual use of these powers.

Risk Mitigation

There are some key risks to handle in conducting a Scottish Capital Spending Review ahead of the certainty around future UK Government block grant allocations that would usually flow from a multi-year Comprehensive Spending Review.  The principal risk is that UK comprehensive spending review allocations, once known, might be significantly lower than the allocations the Scottish Government has pro-actively set out in the plans published here, requiring reprioritisation to take place.  Should block grant allocations be higher than the assumptions underpinning this Capital Spending Review, there would be opportunities to revisit currently proposed spending and capital borrowing plans.

It is important to be transparent around the nature of these risks, and to have plans to mitigate them.

Mitigation options include:

• Revisiting capital borrowing plans, to deploy the right amount to achieve desired outcomes now whilst leaving sufficient headroom for later years.
• Use of the Scotland Reserve to smooth profiles and spend between years.
• Flexing the rate of increase in annual investment in capital maintenance.  This includes asset enhancement, major equipment and fleet.
• Accelerating or delaying commencement of agreed projects.
• Potential to include additional new capital plans should more funding become available.